Friday, March 6, 2009

The Next Shoe To Drop: Pension Funds

This is not likely news to anyone who still has the fortitude to read the papers, but pension funds around the world have been posting staggering losses.

Even though fraudsters like Bernie Madoff and Allen Stanford get most of the press, many of our largest pension funds operate with essentially the same business model. The only difference is that there is a small amount of promised assets in existence with pension funds, whereas with those two clowns (and more to come), there was nearly nothing.

Pension funds typically only have a fraction of the assets they have promised future retirees. The rest is "assumed" to be there based on "projected returns" after investments of those assets. Typically, the funds assume a return of 6-8% annually. Lotteries function in the same way. This is why if you decide to take all of your winnings immediately, it is less than the jackpot amount. They don't have it. "Yet."

Now this would be all well and good if our best and brightest were engaged in investing the money wisely and could reliably be able to provide the advertised returns. Those engaged in selling Modern Portfolio Theory (MPT) promised us that is was possible. MPT teaches that if we spread our investments out over many different asset classes and across the globe, we can guarantee predictable returns in excess of X%. Unfortunately, MPT is one of the biggest lies ever told. 2008 served as evidence of that. 2009 is following the same path. All asset classes everywhere are plummeting together. This was something that was supposed to be "basically impossible" according to MPT and the Efficient Market Hypothesis (another total fraud). Both have been thoroughly discredited.

And the evidence is shocking (not in this corner, but to most).

Caisse de dépôt et placement du Québec, Canada's largest institutional fund manager posts $38,900,000,000 loss in 2008. 25% of the fund's assets. Gone. In one year.

The California Public Employees Retirement System (Calpers) has lost $92,000,000,000 over the 16 months ending January. 35% of it's total assets. The California State Teachers Retirement System (Calstrs) did it's best to match that with $60,600,000,000 over the same period. 34% of it's assets.

These are by far the worst of the worst - that we know about. But there are many smaller funds that have run into the same problems. Bloomberg does a decent job in reporting that in Hidden Pension Fiasco May Foment another $1 Trillion bailout.

"A trillion here, a trillion there. Sooner or later we're talkin' real money."

But now that the losses have piled in, people are starting to wonder. If they were so heavily reliant on future returns to achieve their stated goals, what will a setback like 2008 mean? "Not to worry," say pension fund managers. "When the stock markets recover, so will your pension funds."

Phew. Now I feel better.

Another subject, related to pension funds, but far different structurally is the US Social Security Program. I don't believe any information given about this monstrosity because it is almost always given by interest groups either seeking to profit from it's privatization or from it's continued mismanagement by the government. In the end, we have no idea when that ponzi scheme is going to run out of dough. But we do know a few things.

First, the scheme is invested solely in Treasury Bonds. So one assumption must be that the US government is able to stay solvent - no longer a trivial question. Second, because the yields on those bonds have dropped significantly, the "assumed" returns on that investment are going to be much more optimistic than in reality. And third, with the economy going in the tank and unemployment rising, the "assumed" contributions are likely to also be more optimistic than in reality.

All over the world, grandiose assumptions were made based on a neoclassical belief in the ability to mathematically model the economy and the markets. No such thing can be done. Sadly, we are being held hostage to those failed beliefs now that they are unravelling. A rational person would think to eliminate the failed policies that led us here. Instead, we have decided to double down on our bets and "hope" things turn around quickly.

And if they don't?

I don't typically do advice on this blog. However, if you have a significant portion of your retirement money invested for you in a pension fund, I would suggest you look at the possibility of early withdrawl or opt-out regardless of "penalties." In reality the penalty they are charging you is not a penalty at all. It is how much they currently have of your promised money. Surely, you are able to competently invest your money better than the hucksters doing so now.

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Anonymous said...

and what about RRSP s?

similar story?

Matt Stiles said...

There's far too many variables for each individual person for me to suggest what one should do with their RRSPs (or 401k in the US) at this point. If you asked me a year ago, I would have told you to sell what ever you had in any asset class. But nobody wanted to listen to me at that point.

Most RRSPs are just invested in mutual funds. I'm sure you've already got the statement telling you how well those did last year.

Panicking at a time like today is a statistically poor option. It all depends on your personal situation though.

E-mail me if you want specific questions answered

Anonymous said...

thanks Matt,

actually I moved them in October 08 to GICs, as soon as the storm started... this year again I bought GICs... at least they offer a 3,25%.. better than the negative yield of the RRSPs

Anonymous said...

a few months ago the market looked like a bottom and now it looks like a top. Ditto for stocks today. In one year Dow 6500 will look good.

mannfm11 said...

This thing is going to deflate unless they sever money from its collateral. then it will collapse. The percentage losses, what people will lose from here to the bottom will be greater than what someone has lost from the top if they get out now, meaning $1 million at the top and taken out now is going to be more than $1 million now and taken out at the bottom. Being that all big bears force the accumulation in the former bull market to sell, we are going down a long ways. Do a US CPI on 572 for the Dow for 1975. We are in worse shape than we were then and having a hell of a time inflating.

IN ANY case, I did a lot of study of the pensions the last time around the bowl in 2002. They had cooked up funny calculations to justify under funding them,stuff like 8% returns forever. Of course, the market came back and bailed them out for a little bit, but now we are looking at 8% returns since 1996 being replaced by 2% returns, which means they are now 50% short and need 100% to get even. My guess is the market is damaged to the point that 50% of the earnings and dividends will be gone, growth will be slow or nonexistant and we probably trade at a 6% dividend and maybe a 8 PE.

Namke von Federlein said...

Actually, the pension stuff has been visible for quite some time. The web site called Pension Tsunami is tracking it.

Just a note about dropping shoes. The web site Financial Armageddon just posted Mar 6th about a much more refined problem - the $350 billion in Stable Value Funds. The blog post is entitled 'More Soles to Hit the Fan'.

I must say, I'm enjoying your blog! Hope these references help. I don't include links. On sites where I am not known well, I think it is better to just let people Google for information. This provides a first line of defense against site hacks.

Example : Financial Sense got hacked on March 4th and is still having trouble getting up and running. Keep your spam and site filters on Maximum!

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